from Follow the Money

So, where is the rebalancing?

July 11, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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China flirted with the radical step of letting its exchange rate rise to …. 7.987 on Monday.    but apparently that was too much.   Yesterday, the exchange rate closed at 7.991, back in the PBoC’s comfort range.   

This year, the RMB has appreciated by maybe 1% against the dollar – and fallen by a lot more against the euro.  In the meantime, China’s trade surplus continues to surge.  It reached $14.5b in June, powered by a 25% increase in exports (y/y).   

China’s first half trade surplus is about 50% bigger than its surplus in the first half of 2005, which itself was considered quite large.    Assume that holds for the year.  China’s trade surplus (with the world) would rise to $150b or so, up $50b from 2005.  Its current account surplus would be even bigger – perhaps $200b.   All that interest income on China’s $1 trillion in reserves! I will though concede there is something a bit strange with China’s current account number, since some of the income surplus should be offset by profits on foreign FDI in China.

What of the other big Asian surplus country – Japan.  Is the resurgence in domestic demand leading Japan’s trade surplus to fall?   Uh no.   Its May trade surplus was up substantially from a year ago.  And with the interest income on Japan’s massive holdings on Treasuries rising, its current account surplus should be growing too. 

The impact of the resurgence of Japanese growth on the US trade balance strikes me as massively overstated.  Japan has a big economy.  But it doesn’t import that many manufactured goods, as least not relative to its GDP.  And most of the goods that it does import don’t come from the US.   You need an awfully big elasticity for 2% Japanese growth to generate a huge surge in the dollar value of US exports to Japan (around $55b in 2005).   Particularly with the yen very weak in real terms.   Japan needs to grow with a strong yen -- not grow with a weak yen -- to contribute to global rebalancing.

The rest of developing Asia -- counting India -- actually doesn’t have much of a surplus anymore.   And Korea's surplus is falling.  Oil imports.  (Edited for greater precision) 

Indeed, Bill Pesek makes a point that Americans who argue that since the US can never compete with cheap Chinese labor, it should therefore want China to keep its exchange rate low to keep the cost of US imports from China down might want to consider.  

China is not just running a massive trade surplus with the US.  It is also running a huge trade surplus with Bangladesh.  For that matter, Chinese goods are taking market share in Africa as well.   There supposedly is a store in Namibia called “China cheap.”   No false advertising. 

Of course, even as China competes with emerging economies who produce manufactured goods, it sucks up commodities from the world. 

With oil fluctuating between $70 and 75 it is safe to say that the other big surplus region in the global economy – the arc of oil exporters that runs from Venezuela to West Africa to North Africa to the Middle East up through central Asia to Russia – has a growing surplus. 

Contrast that with financial turmoil in a set of emerging market deficit countries – whether Turkey, Hungary or India.  I suspect these countries will either see their deficits shrink (Turkey) or not grow as fast.  

Rising surpluses in the surplus regions of the world economy.  Financial turmoil in emerging markets with current account deficits.    

The obvious implication for the global balance:  rising current account deficits in other industrial countries.

Surplus in one place have to be offset by deficits elsewhere.  And with two big oil importers – China and Japan – posting rising surpluses, that means even bigger deficits in other oil importers. 

The only big question is whether the increase in the deficit of oil importers will come in Europe.  Or in the US.  

I would bet on a bit of both.   But it would surprise me to see the US deficit expand more.

Everyone is talking about a forthcoming slowdown in US (non-oil) import growth on the back of a slowing US economy.  Morgan Stanley’s house view seems to be that the US current account deficit has peaked.  I am not as sanguine.  I think they may be looking at only one side of the ledger.  I expect that US import growth will slow, at least on a y/y basis.  But that slowdown may be matched by a slowdown in US export growth.     Boeing can only boom once.   The lagged impact of the dollar’s slide to 1.25 (v. the euro) in 2003 will wear off.    Chinese import growth may slow a bit.   Its boom in the first half was a bit too fast to be sustained.    The booms in consumption in India and Turkey will slow, if not disappear.   The oil exporters have plenty of scope to increase spending.  But what are the chances they will buy American? 

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